UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the period ended March 31, 1996
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Act of 1934
For the transition period from __________ to __________
Commission file number 0-15768
NORTH CAROLINA RAILROAD COMPANY
(Exact name of registrant as specified in its charter)
NORTH CAROLINA 56-6003280
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
234 Fayetteville Street Mall, Suite 600
P. O. Box 2248, Raleigh, North Carolina 27602
(Address of principal executive offices) (Zip Code)
(919) 829-7355
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practical
date.
Common Stock, $.50 par Value--4,283,470 shares as of
March 31, 1996.
The total number of pages contained in this document is 21 pages.
INDEX
NORTH CAROLINA RAILROAD COMPANY
PART I. FINANCIAL INFORMATION
Item l. Financial Statements (Unaudited)
Balance Sheets - March 31, 1996 and
December 31, 1995 . . . . . . . . . . . . . . . . . 3
Statements of Income - Three months ended March 31,
1996 and March 31, 1995 . . . . . . . . . . . . . . 4
Statements of Shareholders' Equity -
Three months ended March 31, 1996
and March 31, 1995 . . . . . . . . . . . . . . . . . 5
Statements of Cash Flows -
Three months ended March 31, 1996 and
March 31, 1995 . . . . . . . . . . . . . . . . . . . 6
Notes to financial statements -
March 31, 1996 . . . . . . . . . . . . . . . . . . . 7
Item 2. The Registrant's Discussion and Analysis of
Financial Condition and Results of Operations. . . . 12
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . 21
2
BALANCE SHEETS (Unaudited)
NORTH CAROLINA RAILROAD COMPANY
March 31 December 31
1996 1995
------------- -------------
ASSETS
Cash and cash equivalents $14,565,336 $15,139,497
Short term investments -0- 190,000
Interest receivable 75,810 4,447
Prepaid expenses 74,398 -0-
------------ ------------
TOTAL CURRENT ASSETS 14,715,544 15,333,944
PROPERTIES
Roadway and land--Note C 7,848,842 7,848,842
Buildings and equipment 241,474 241,469
Less accumulated depreciation (301,774) (299,559)
------------ ------------
7,788,542 7,790,752
------------ ------------
OTHER ASSETS
Lease negotiation costs, net of 1,362,150 1,355,568
amortization of $58,428 ------------ ------------
$23,866,236 $24,480,264
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accrued expenses and accounts payable $ 768,949 $ 854,398
Income taxes payable 3,446,855 5,230,277
Unearned rental income 61,000 -0-
------------ ------------
TOTAL CURRENT LIABILITIES 4,276,804 6,084,675
DEFERRED INCOME TAXES 1,212,451 1,209,851
COMMITMENTS AND CONTINGENCIES--Note D
SHAREHOLDERS' EQUITY
Common stock, par value $0.50 per share--
10,000,000 shares authorized, 4,283,470
shares issued and outstanding 2,141,735 2,141,735
Additional paid-in capital 3,588,455 3,588,455
Retained earnings 12,646,791 11,455,548
------------ ------------
18,376,981 17,185,738
------------ ------------
$23,866,236 $24,480,264
============ ============
See notes to financial statements.
3
STATEMENTS OF INCOME (Unaudited)
NORTH CAROLINA RAILROAD COMPANY
Three Months Ended
March 31
1996 1995
--------------------------
Revenues:
Lease of roadway and land $2,062,429 $ 168,569
Interest income 215,848 31,504
Rental income 600 3,150
Other 277 30,234
---------- -----------
2,279,154 233,457
Expenses:
Salaries and administrative 63,024 61,106
Professional fees 92,008 116,229
Insurance and taxes 30,447 16,332
Amortization expense 11,685 -0-
Depreciation 2,215 1,791
Consulting fees 18,918 14,651
Other 17,936 26,692
---------- ----------
236,233 236,801
INCOME BEFORE INCOME TAXES 2,042,921 (3,344)
Income taxes:
Current 849,078 -0-
Deferred 2,600 2,600
---------- -----------
851,678 2,600
---------- -----------
NET INCOME $1,191,243 $ (5,944)
========== ===========
Earnings per share: $0.28 $0.00
====== ======
See notes to financial statements.
4
STATEMENTS OF SHAREHOLDERS' EQUITY (Unaudited)
NORTH CAROLINA RAILROAD COMPANY
Additional
Common Paid-In Retained Shareholders'
Shares Capital Earnings Equity
---------- ---------- ------------ -------------
Balance at January 1, 1995 $2,141,735 $3,588,455 $ 2,590,626 $ 8,320,816
Net income (5,944) (5,944)
---------- ---------- ------------ ------------
Balance at March 31, 1995 $2,141,735 $3,588,455 $ 2,584,682 $ 8,314,872
========== ========== =========== ===========
Balance at January 1, 1996 $2,141,735 $3,588,455 $11,455,548 $17,185,738
Net income 1,191,243 1,191,243
---------- ---------- ----------- -----------
Balance at March 31, 1996 $2,141,735 $3,588,455 $12,646,791 $18,376,981
========== ========== =========== ===========
See notes to financial statements.
5
STATEMENTS OF CASH FLOWS
NORTH CAROLINA RAILROAD COMPANY
Three Months Ended
March 31
1996 1995
-----------------------------------
OPERATING ACTIVITIES
Net income $1,191,243 $ (5,944)
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Deferred income taxes 2,600 2,600
Depreciation and amortization 13,900 1,791
Lease negotiation costs (18,268) (56,256)
Change in operating assets and liabilities:
Rent receivable -0- 113,342
Interest receivable (71,363) (12,359)
Other assets (74,398) -0-
Income taxes recoverable -0- (16,130)
Accrued expenses (85,453) 3,366
Unearned rental income 61,000 61,000
Income taxes payable (1,783,422) -0-
------------ ---------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (764,161) 91,410
INVESTING ACTIVITIES
Purchase of short-term investments -0- (673,000)
Maturity of short-term investments 190,000 -0-
---------- ----------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 190,000 (673,000)
FINANCING ACTIVITIES
Dividends paid -0- (128,504)
---------- ----------
NET CASH USED IN FINANCING ACTIVITIES -0- (128,504)
DECREASE IN CASH AND CASH EQUIVALENTS (574,161) (710,094)
Cash and cash equivalents at beginning of period 15,139,497 1,615,284
----------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $14,565,336 $ 905,190
============ ===========
See notes to financial statements.
6
NOTES TO FINANCIAL STATEMENTS
NORTH CAROLINA RAILROAD COMPANY
NOTE A--SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited financial statements have been
prepared in accordance with generally accepted accounting
principles for interim financial information. Accordingly, they
do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements.
In the opinion of management, the financial statements
contain all adjustments (consisting of only normal recurring
adjustments) necessary to present fairly the financial position
and results of operations of North Carolina Railroad Company (the
"Company" or "NCRR") as of and for each of the periods presented.
These financial statements should be read in conjunction with the
financial statements and notes included in the Company's audited
financial statements for 1995.
PROPERTIES: Properties in the roadway and land account are
carried at an amount which approximates the 1916 valuation by the
Interstate Commerce Commission. These properties are not
depreciated because they represent fully depreciated roadway or
non-depreciable land.
INCOME TAXES: The income tax provision does not take into
account the Company's possible Real Estate Investment Trust
("REIT") election for 1995 or Norfolk Southern's potential
liability for the Company's taxes should the Lease Extension
Agreement not be effective. (See Note B and Note C.)
CASH AND CASH EQUIVALENTS: Cash and cash equivalents
include investments in commercial paper, U. S. Treasury Bills,
and certificates of deposit with original maturities of three
months or less. Cash deposits are placed with high credit
quality financial institutions. Deposits exceed amounts insured
by the Federal Deposit Insurance Corporation.
SHORT-TERM INVESTMENTS: Short-term investments include
investments in high quality commercial paper and U. S. Treasury
Bills with maturities within one year of the balance sheet date.
These investments are held-to-maturity and are carried at cost,
which approximates market.
LEASE/TRANSACTION COSTS: Certain lease negotiation costs
have been capitalized and are being amortized over the life of
the Lease Extension Agreement. (See Note C.)
7
NOTE B--REAL ESTATE INVESTMENT TRUST
On August 10, 1995, the Board of Directors of the Company
voted to cause the Company to elect REIT status for income tax
purposes, in connection with the Lease Extension Agreement. (See
Note C.) The REIT provisions of the Internal Revenue Code
("I.R.C.") generally allow a REIT to deduct distributions paid to
its stockholders. The Company received an opinion of counsel
that the Company can qualify as a REIT based upon the
effectiveness and terms of the Lease Extension. However, certain
shareholder litigation could enjoin, delay, or otherwise affect
the effectiveness of the Lease Extension, the terms of the Lease
Extension, or the timing or amount of shareholder distributions.
The Company is also seeking a ruling from the Internal Revenue
Service as to the effect of a one-time $5 million settlement
payment with respect to the timing of the Company's REIT
election, but the Company has not yet received such ruling.
There can be no assurance that the Company can qualify for REIT
status for 1995 or later years.
If the Company qualifies for and elects to become a REIT for
1995 and 1996, and recognizes the December 1995 payment of
additional rent ratably over all of 1995, lease revenue, income
before income taxes, income taxes, net income, and earnings per
share on a pro-forma basis would be as follows:
Three Months Ended Three Months Ended
March 31, 1996 March 31, 1995
(Unaudited)
-------------------------------------
Lease of Roadway and Land $ 2,062,429 $ 2,079,702
Income before Income Taxes 2,042,921 1,907,789
Income Taxes 41,600 30,800
Net Income 2,001,321 1,876,989
Earnings per Share .47 .44
The pro forma effect of REIT election and recognition of the
1995 lump sum rental payment ratably for the three month period
ended March 31, 1995 would be $.44 per share, and the effect of
REIT election for the three month period ended March 31, 1996
would be $.19 per share.
NOTE C--LEASES ON ROADWAY AND LAND
In 1895, the Company leased substantially all of its assets
to Southern Railway Company, now known as Norfolk Southern
Railway Company ("NSR"), for ninety-nine years (the "1895
Lease"). In 1989, the Company acquired the Atlantic and North
Carolina Railroad Company, the assets of which were subject to a
lease dating to 1939 with the Atlantic & East Carolina Railway
Company ("AECR"), a wholly-owned subsidiary of Norfolk Southern
8
Railway Company (the "1939 Lease"). NSR and AECR are hereinafter
referred to as "Norfolk Southern". The terms of the 1895 Lease
and 1939 Lease provided for expiration on January 1, 1995 and
December 31, 1994, respectively, and did not require either the
Company or Norfolk Southern to renew the leases.
On August 10, 1995, the Board of Directors of the Company
approved a Lease Extension Agreement ("Lease Extension") to
extend the terms of the 1895 Lease and the 1939 Lease, with its
effectiveness retroactive to January 1, 1995. However, a
shareholder has commenced a legal action challenging the validity
of shareholder approval. Other shareholder derivative litigation
seeking to enjoin the Lease Extension is also pending. The base
annual rental under the Lease Extension is eight million dollars
($8,000,000) for the period from January 1, 1995 through December
31, 1995. Annual base rent for 1996 and each year thereafter
will be adjusted each year to account for inflation during the
preceding calendar year according to the implicit price deflator
for the gross domestic product (IPD-GDP). In no event, however,
will the base annual rental for any calendar year be less than
eight million dollars ($8,000,000). The base rent adjustment in
any year cannot exceed the sum of: (i) four (4%) percent of the
base rent for the preceding year, plus (ii) seventy-five (75%)
percent of the IPD-GDP in excess of four (4%) percent. There is
a one-year delay in application of the IPD-GDP. For example,
adjustment of 1995 rental payments to determine 1996 rental
payments is based upon the IPD-GDP for 1994. The 1895 and 1939
Leases are extended for an initial term of thirty (30) years,
through December 31, 2024 and are extendable for an additional
twenty (20) years at the option of Norfolk Southern.
Following approval of the Lease Extension, Norfolk Southern
paid approximately $7.8 million to the Company for 1995 as called
for in the Lease Extension. If this payment had been recognized
ratably over all of 1995, lease revenue, income before income
taxes, income taxes, net income, and earnings per share on a pro
forma basis would be as follows:
Three Months Ended
March 31, 1995
(Unaudited)
------------------
Lease of Roadway and Land $ 2,079,702
Income before Income Taxes 1,907,789
Income Taxes 800,843
Net Income 1,106,946
Earnings Per Share .26
A third lease to Norfolk Southern (the "1968 Lease") expires
on December 31, 2067, and provides for an annual rental of
$81,319 through December 2017 for certain properties in
Charlotte, North Carolina. Beginning on January 1, 2018, 6% of
9
the appraised value of the property will be the annual rental for
the remaining term of the 1968 Lease. Under the terms of the
1968 Lease, all taxes connected with the property, except income
taxes, are paid by the lessee. The 1968 Lease would not be
affected by the Lease Extension.
NOTE D--COMMITMENTS AND CONTINGENCIES
In January, 1994, North Carolina Department of Environment,
Health, and Natural Resources ("DEHNR") initiated a lawsuit
against the Company and other parties seeking reimbursement of
$84,354 in response costs incurred by DEHNR and remediation of
the Peele environmental site. Information about the litigation
has been disclosed by the Registrant in prior annual and
quarterly reports to the Securities and Exchange Commission. The
Registrant is one of several defendants that have been held
jointly and severally liable for response costs and remediation
of the site. The Court has not yet ruled on apportionment of
liability or cost sharing among the defendants. According to a
preliminary study conducted by the Company, the estimated costs
of remediation range between $500,000 to in excess of $2,000,000.
The ultimate costs of any remediation, removal, or clean-up are
not known. However, if such costs are not paid by other parties,
the financial position of the Company could be materially
adversely affected.
Four shareholder derivative actions were filed in the United
States District Court for the Eastern District of North Carolina
during December 1994 and January and February 1995 by
shareholders of the Company. The complaints name the directors
of the Company as defendants and the Company as "nominal
defendant." Two of the actions seek to enjoin a purported lease
between the Company and Norfolk Southern and seek to recover for
the Company unspecified damages and other relief from the
directors. Two other actions seek similar relief and also name
the State of North Carolina, the Governor of North Carolina, and
Norfolk Southern as defendants. On December 21, 1995, a
shareholder derivative legal action was filed. The action seeks
to enjoin the Lease Extension or invalidate the December 15, 1995
shareholders meeting held to approve the Lease Extension on the
basis of a lack of a quorum of shareholders other than the State
of North Carolina, and makes other allegations against the
defendants, including alleged proxy rule violations. The Company
is defending the aspects of the shareholder suits relating to the
shareholder meeting, the effectiveness of the Lease Extension,
and attempts to enjoin the Lease Extension. The directors and
officers named as defendants in the suits, represented by
separate counsel, are defending damage claims brought against the
directors and officers. The Company's officers and directors are
indemnified in the bylaws of the Company for certain claims and
liabilities alleged in the actions, including the defense costs
10
and expenses. The Company notified its directors and officers
insurance carrier of claims as a result of the actions, which
claims have been acknowledged by the insurance carrier. The
directors and officers insurance policy has an aggregate limit of
$5,000,000 and a $75,000 retention per occurrence.
On December 10, 1991, the Company initiated a lawsuit in the
Mecklenburg County, North Carolina Superior Court regarding its
railroad corridor through downtown Charlotte. The Company
alleged that both the City of Charlotte and Norfolk Southern have
breached contract obligations and obligations based on real
property rights to the Company. The litigation has been
disclosed by the Company in prior quarterly and annual reports to
the Securities and Exchange Commission. The Company is engaging
in negotiations to settle the litigation, but there can be no
assurance of any settlement or the terms of any such settlement.
11
Item 2. The Registrant's Discussion and Analysis of Financial
Condition and Results of Operations
Overview and Background
A majority of the Registrant's assets were subject to two
railroad operating leases dating to 1895 and 1939, which by their
terms provided for expiration at the end of 1994. Information
about the leases has been disclosed by the Registrant in prior
quarterly and annual reports to the Securities and Exchange
Commission.
During the fourth quarter of 1994, the Registrant and
Norfolk Southern reached tentative agreement on the primary terms
of a long term agreement to extend the 1895 and 1939 Leases.
However, a definitive agreement had not been reached as of the
expiration dates of the 1895 and 1939 Leases at the end of 1994,
and the Registrant and Norfolk Southern entered into a temporary
arrangement to continue the rental and other terms of the 1895
and 1939 Leases beginning in 1995. During 1995, Norfolk Southern
continued to make rental payments under the terms of the 1895 and
1939 Leases.
On August 10, 1995, the Board of Directors of the Registrant
approved a Lease Extension with Norfolk Southern. The Lease
Extension would extend the terms of the 1895 Lease and the 1939
Lease, and the effectiveness of the Lease Extension is
retroactive to January 1, 1995. On August 24, 1995, the Board of
Directors of NSR and the Board of Directors of AECR approved the
Lease Extension. On December 15, 1995, the Registrant held a
shareholder meeting to approve the Lease Extension, which meeting
is being challenged in court. See Item 3, Legal Proceedings,
regarding litigation challenging the validity of shareholder
approval and seeking to enjoin the Lease Extension.
Liquidity and Capital Resources
Pursuant to the Lease Extension, the Registrant's lessees
pay for maintenance and all operating railroad equipment.
Therefore, the Registrant does not anticipate any need for
substantial capital expenditures unless the Lease Extension is
deemed not to have been approved by the shareholders at the
December 15, 1995 shareholder meeting.
If shareholder approval of the Lease Extension is deemed
invalid and the Lease Extension is not approved by the
shareholders at a future shareholder meeting, and the Registrant
is unable to negotiate other leases upon acceptable terms,
operating its own line without a lessee would subject the
Registrant to a number of risks that would materially affect the
Registrant's liquidity and capital resources. The Registrant
anticipates that it would have to incur substantial operating
12
expenses over time, but that it would initially not likely incur
substantial capital expenditures with respect to fixed plant.
Under the terms of the 1895 Lease, the lessee is required to
return the leased properties, or equivalent replacements of
leased properties, including equipment, in as good a condition
and repair as the property was at the inception of the lease,
less ordinary depreciation. However, the Registrant may be
required to incur substantial capital expenditures and other
expenses for the operation of the railroad line if the equipment
is not returned in operating condition upon termination of the
leases or if the quantities or type of the returned equipment is
insufficient to operate the railroad line. Pursuant to a
separate agreement for the payment of $5.2 million (including
interest) by Norfolk Southern on December 1, 1995 in settlement
of certain personal property and equipment claims as called for
the Lease Extension, the settlement payment is not required to be
returned to Norfolk Southern in the event the Lease Extension is
invalidated or enjoined. Pursuant to the agreement, the payment
is to be credited against any sums or rentals ultimately
determined to be due to the Registrant from Norfolk Southern.
Therefore, in such event, the Registrant's claims for certain
personal property and equipment or other claims would be offset
by the payment amount.
Notwithstanding Norfolk Southern's knowledge of the
shareholder derivative actions challenging approval of the Lease
Extension and the Registrant's failure to confirm the
effectiveness of the Lease Extension, on December 28, 1995
Norfolk Southern paid the Registrant approximately $7.8 million,
which is the amount that would have been owed to the Registrant
under the terms of the Lease Extension had the Lease Extension
become retroactively effective as of January 1, 1995. During
1996 to date, Norfolk Southern has continued to make payments to
the Registrant in amounts that would be due if the Lease
Extension is effective, approximately $680,000 monthly. There
can be no assurance, however, that Norfolk Southern will continue
to make such payments. Nonetheless, the Registrant does not
foresee any need for funds during 1996 which cannot be met
primarily from available cash. However, see Item 3, Legal
Proceedings, regarding litigation challenging the validity of
shareholder approval and seeking to enjoin the Lease Extension.
In the event shareholder approval of the Lease Extension is
deemed invalid, if the Registrant and Norfolk Southern litigate
lease compensation or abandonment issues before the United States
Surface Transportation Board, (the successor agency to the
Interstate Commerce Commission), claims under the 1895 and 1939
Leases, or other matters, the Registrant may be required to
finance part of the litigation expenses.
In order to qualify as a REIT for federal income tax
purposes, the Registrant is required to make distributions to its
stockholders of at least 95% of REIT taxable income, which will
13
limit the Registrant's ability to accumulate working capital if
the Registrant elects REIT status. See "Real Estate Investment
Trust Election" below. The Company expects to use its cash flow
from operating activities for distributions to stockholders and
for payment of operating expenses. The Company intends to invest
amounts accumulated for distribution in short-term investments.
The Registrant's liquidity (cash and short-term investments)
decreased from $15,329,497 at December 31, 1995 to $14,565,336 at
March 31, 1996. Short-term investments in U. S. Treasury Bills
of $190,000 will mature within 90 days of the balance sheet date.
The Registrant's cash and cash equivalents decreased by $574,161
from December 31, 1995 to $14,565,336 at March 31, 1996.
For the three month period ended March 31, 1996, $764,161 of
net cash was used in operating activities and was primarily
attributable to net income of $1,191,243, which was offset by
$1,783,422 of income taxes payable.
Investing activities resulted in a net use of cash of
$190,000 as short-term investments will mature within 90 days of
the balance sheet date.
Results of Operations
Results of operations for the periods covered hereby reflect
payments to the Registrant from Norfolk Southern. Payments
received until December, 1995 were received pursuant to the terms
of the 1895 Lease and 1939 Lease under a temporary arrangement
between the Registrant and the lessees which continued the rental
and other terms of the Leases. In December, 1995, Norfolk
Southern made a payment of approximately $7.8 million as called
for in the Lease Extension for additional 1995 rental, and
beginning in January, 1996, began making monthly payments in the
amount called for in the Lease Extension for 1996 rental. See
Item 3, Legal Proceedings, regarding shareholder litigation
seeking to enjoin the Lease Extension or invalidate shareholder
approval of the Lease Extension. If the $7.8 million payment
described above were recognized ratably over 1995, revenue from
lease of roadway and land, income before income taxes, income
taxes, net income, and earnings per share would be substantially
higher for the period ended March 31, 1995, as noted below.
Total revenues increased from $233,457 for the three month
period ended March 31, 1995 to $2,279,154 for the same period
ended March 31, 1996. The increase was attributable primarily to
an increase in revenue from leases of roadway and land.
Interest income increased from $31,504 for the three month
period ended March 31, 1995 to $215,848 for the same period ended
March 31, 1996. The increase was primarily attributable to an
increase in average levels of invested cash.
14
Rental income decreased from $3,150 for three month period
ended March 31, 1995 to $600 for the same period ended March 31,
1996. The Registrant's rental income is derived from
miscellaneous leases of the Registrant's properties.
Salary and administrative expenses increased slightly from
$61,106 for the three month period ended March 31, 1995 to
$63,024 for the same period ended March 31, 1996.
For the three month period ended March 31, 1996,
professional fees paid by the Registrant decreased to $92,008 as
compared to $116,229 for the same period ended March 31, 1995.
Professional fees relate to attorneys' and accountants' fees paid
for various filing and reporting requirements, certain litigation
and other general items. The decrease was attributable to lower
professional fees associated with the Registrant's preparation
for termination of its leases, evaluation of REIT qualification,
and litigation fees.
Insurance and taxes increased to $30,447 for the three month
period ended March 31, 1996 as compared to $16,332 for the same
period ended March 31, 1995. The increase is primarily
attributable to an increase in the Registrant's directors and
officers insurance premiums, which increases the Registrant
expects to continue to incur in future periods. The Registrant
also expects to incur higher property tax expense in future
periods to the extent properties are excluded from the Lease
Extension for separate management by the Registrant.
The majority of investment banking fees and other fees
associated with the Lease Extension are currently being
capitalized for financial reporting and income tax purposes and
will be amortized over the 30-year term of the Lease Extension.
Amortization expense of $11,685 for the three month period ended
March 31, 1996 related to capitalized lease negotiations costs.
Consulting fees increased from $14,651 for the three month
period ended March 31, 1995 to $18,918 for the same period ended
March 31, 1996. Consulting fees are attributable to the number
and magnitude of projects, primarily in connection with the Lease
Extension, and environmental assessment fees. The Registrant
expects to continue to incur substantial consulting fees,
investment banking fees, attorneys' and accountants' fees and
related expenses in future periods until litigation and matters
related to the Lease Extension are resolved.
Other expenses include supplies, utilities, postage, office
rent, printing, and miscellaneous items. For the three month
period ended March 31, 1996, other expenses were $17,936 as
compared to $26,692 for the same period ended March 31, 1995.
Net income tax expense increased to $851,678 for the three
15
month period ended March 31, 1996 as compared to $2,600 for the
same period ended March 31, 1995. The increase is attributable
to substantially higher net income from payments under the Lease
Extension, pursuant to which all income taxes become the
responsibility of the Registrant as of January 1, 1995. Under
the 1895 Lease, all taxes, including income taxes attributable to
the lease, were the responsibility of Norfolk Southern as lessee.
The 1995 income tax provision does not take into account the
Registrant's possible REIT election for 1995 and 1996 or Norfolk
Southern's potential liability for the Registrant's taxes should
the Lease Extension not be effective. See "Real Estate
Investment Trust Election" below and Note B and Note C to the
financial statements.
If the $7.8 million Norfolk Southern payment received in
December, 1995 were recognized ratably over all of 1995, results
of operations for the period ended March 31, 1995 as compared to
the same period ended March 31, 1996 would be as follows:
Three Months Ended Three Months Ended
March 31, 1996 March 31, 1995
(Unaudited)
---------------------------------------
Lease of Roadway and Land $2,062,429 $2,079,702
Income before Income Taxes 2,042,921 1,907,789
Income Taxes 851,678 800,843
Net Income 1,191,243 1,106,946
Earnings Per Share .28 .26
Inflation affects the Registrant primarily through increased
salary, administrative, property tax, and insurance expenses.
The Registrant's primary sources of revenue prior to 1995, rental
from the 1895 Lease and 1939 Lease, increased only to the extent
changes in the general inflation rate increase the excess rental
payments under the 1939 Lease. The Lease Extension contains an
annual inflation adjustment provision, which resulted in an
increase in base rental of $42,100, or 2.1%, for the quarter.
The Registrant and its lessees are responsible for
compliance with state, federal, local or other provisions
relating to discharge of materials or the protection of the
environment. The risk of incurring environmental liability is
inherent in conducting railroad operations. Some of the
commodities which are transported over the Registrant's railroad
lines are classified as hazardous materials. The 1895 and 1939
Leases did not make provision for the lessees to disclose
environmental problems affecting the Registrant's properties.
Environmental problems may exist on properties owned by the
Registrant which are known to the lessees but have not been
disclosed to the Registrant or which are unknown to the lessee or
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the Registrant. State and federal environmental provisions may
impose joint and several liability upon the Registrant and its
lessees and sublessees for environmental damage or clean up (or
associated costs) of any real properties owned by the Registrant
and adjoining properties if the source of any problem is the
property of the Registrant. The Registrant believes that damage
or clean up (or the associated costs) would be the responsibility
of the lessees and any sublessees or other parties who may have
created any actionable environmental condition. The Lease
Extension contains extensive provisions governing the rights and
obligations of the parties for various environmental liabilities
and expenses. If the Lease Extension is invalidated or enjoined,
the Registrant may determine that it is in its interest to
initiate substantial environmental assessments of its properties
and commence environmental litigation against Norfolk Southern
and its sublessees or other parties who may have created or who
are responsible for any actionable environmental conditions.
However, if such parties are not able to meet their
responsibilities, under certain statutes, regulations, and rules,
the Registrant could ultimately be held responsible for any
remediation, removal, or cleanup of the property it owns. The
Lease Extension does not affect the responsibility of the
Registrant with respect to the Peele Site.
The status of the Peele environmental site is disclosed in
Item 3 "Legal Proceedings." According to a preliminary study
conducted by the Registrant, the estimated costs of remediation
range between $500,000 to in excess of $2,000,000. At this time,
the Registrant does not know the total amount of its financial
exposure, the timing of the resolution of the matter, or the
extent to which the Registrant's potential exposure may be
reduced by contribution or indemnification from other parties.
The Registrant does not have insurance to minimize its potential
exposure. Legal expenses and the costs of remediation, removal,
or cleanup represent a possible substantial future drain on the
financial resources of the Registrant which cannot be quantified
at this time. Any future remediation, removal, or cleanup at the
site should have no effect upon railroad operations.
Real Estate Investment Trust Election
On August 10, 1995, the Board of Directors of the Registrant
voted to cause the Registrant to elect REIT status for income tax
purposes, in connection with the Lease Extension. If the
Registrant qualifies for taxation as a REIT, it generally will
not be subject to federal corporate income taxes on that portion
of its ordinary income or capital gain that is currently
distributed to its shareholders. The REIT provisions of the
Internal Revenue Code ("I.R.C.") generally allow a REIT to deduct
distributions paid to its stockholders. The Registrant received
an opinion of counsel that the Registrant can qualify as a REIT
17
based upon the effectiveness and terms of the Lease Extension.
However, the Registrant is seeking a ruling from the Internal
Revenue Service as to the effect of the $5 million one-time
settlement payment with respect to the timing of the Registrant's
REIT election, but the Registrant has not yet received such
ruling. In addition, certain shareholder litigation could
enjoin, delay, or otherwise affect the effectiveness of the Lease
Extension, the terms of the Lease Extension, or the timing or
amount of shareholder distributions. In that event, the
litigation may delay or even cause the Registrant to be unable to
qualify for REIT status, which would substantially decrease the
after-tax net income available for distribution to shareholders
of the Registrant. See Item 3, Legal Proceedings, for a
description of the shareholder litigation.
In order to be taxed as a REIT, the Registrant is required
to distribute dividends (other than capital gain dividends) to
its stockholders in an amount at least equal to (a) the sum of
(i) 95% of the Registrant's "REIT taxable income" (computed
without regard to the dividends-paid deduction and the
Registrant's capital gain) and (ii) 95% of the net income, if
any, from foreclosure property in excess of the special tax on
income from foreclosure property, minus (b) the sum of certain
items of non-cash income. Such distributions must be paid in the
taxable year to which they relate, or in the following taxable
year if declared before the Registrant timely files its Federal
income tax return for such year and if paid on or before the
first regular dividend payment after such declaration. Even if
the Registrant satisfies the foregoing distribution requirements,
to the extent that the Registrant should fail to distribute
during each calendar year at least the sum of (a) 85% of its
ordinary income for that year, (b) 95% of its capital gain net
income for that year and (c) any undistributed taxable income
from prior periods, the Registrant would be subject to a 4%
excise tax on the excess of such required distribution over the
amounts actually distributed. Under certain circumstances, the
Registrant may be able to rectify a failure to meet the
distribution requirements for a year by paying "deficiency
dividends" to shareholders in a later year, which may be included
in the Registrant's deduction for dividends paid for the earlier
year. Thus, the Registrant may be able to avoid being taxed on
amounts distributed as deficiency dividends. The Registrant
will, however, be required to pay interest based upon the amount
of any deduction taken for deficiency dividends.
Due to the uncertainty over the effectiveness of the Lease
Extension caused by the shareholder derivative actions
challenging the validity of shareholder approval of the Lease
Extension, the Registrant has determined to delay a decision as
to whether to elect REIT status for its 1995 taxable year until
the earlier of the date the uncertainty has been resolved or the
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latest date by which the Registrant may make an election to be
taxed as a REIT for 1995. The Registrant believes it may be able
to qualify for 1995 and later years. If the Lease Extension is
invalidated, the Registrant does not know whether its income for
1995 and later years will qualify the Registrant for REIT status.
The I.R.C. provides that if a taxpayer's REIT election is
terminated by its failure to satisfy the qualification
requirements, the taxpayer may not make a new election to be
taxed as a REIT prior to the fifth taxable year after
disqualification, unless the taxpayer fits within certain narrow
exceptions. Distributions to shareholders in any year in which
the Registrant fails to qualify as a REIT will not be deductible
by the Registrant nor will they be required to be made.
Accordingly, the Registrant will evaluate the tax benefits to be
gained by electing REIT tax status compared to the possible
detriment to the Registrant if the Registrant is disqualified
from REIT tax status for four subsequent taxable years following
any such election. The provisions of the I.R.C. and related
regulations governing the federal income tax treatment of REIT's
are highly technical and complex. There can be no assurance that
the Registrant can qualify for REIT status for 1995 or later
years. (See Note B to the financial statements regarding pro
forma information in the event the Registrant qualifies for REIT
status.)
To ensure that the decision about electing REIT tax status
for 1995 is made with the most reliable information available
under the circumstances, the Registrant has filed applications
for an extension of the time to file its tax returns for tax year
1995 until September 15, 1996. On or before that date, the
Registrant will evaluate all relevant factors in determining
whether to make a REIT election for its 1995 taxable year. Such
factors will include, for example, the status of the shareholder
derivative actions, any discussions with Norfolk Southern about
the Lease Extension, alternatives to the Lease Extension, advice
from the Registrant's professional advisers about the feasibility
of qualifying for REIT tax status if the Lease Extension does not
become effective, and the tax consequences of the Registrant
electing REIT status for 1995, but failing to qualify as a REIT
for 1996, 1997 or later years.
If the Registrant makes a REIT election for its 1995 taxable
year, by delaying certain distributions of 1995 income past
January 31, 1996, the Registrant would incur a federal excise tax
liability of approximately $315,000 for 1995. If the Registrant
does not elect REIT tax status for 1995, the Registrant would
incur an additional 1995 income tax liability of approximately $3
million, in addition to income tax liability of approximately $2
million attributable primarily to taxes on the $5 million
property settlement payment. Under the original terms of the
1895 Lease, which pursuant to a temporary arrangement between the
Registrant and Norfolk Southern are applicable to Norfolk
19
Southern's continued operation after the end of 1994, all taxes,
including income taxes of the Registrant attributable to the
Lease, were the responsibility of Norfolk Southern as lessee. It
is unclear at this time, however, how such a temporary
arrangement would be interpreted by the courts with respect to
tax liability reimbursement.
Cautionary Statement Identifying Important Factors That Could
Cause the Registrant's Actual Results to Differ From Those
Projected in Forward Looking Statements
In connection with the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995, readers of this
document, and any document incorporated by reference herein, are
advised that this document and documents incorporated by
reference into this document contain both statements of
historical facts and forward looking statements. Forward looking
statements are subject to certain risks and uncertainties, which
could cause actual results to differ materially from those
indicated by the forward looking statements. Examples of forward
looking statements include, but are not limited to (i)
projections of revenues, income or loss, earnings or loss per
share, capital expenditures, dividends, capital structure and
other financial items, (ii) statements of the plans and
objectives of the Registrant or its management or Board of
Directors, including estimates or predictions of actions by other
parties or regulatory authorities, (iii) statements of future
economic performance, and (iv) statements of assumptions
underlying other statements and statements about the Registrant
or its business.
This document and any document incorporated by reference
herein also identify important factors which could cause actual
results to differ materially from those indicated by the forward
looking statements. These risks and uncertainties include the
court's disposition of various legal actions challenging the
Lease Extension Agreement, Norfolk Southern's ability and
willingness to divert traffic from the Registrant's line should
the Lease Extension Agreement not become effective, the
Registrant's ability to qualify for tax treatment as a REIT and
other matters which are described herein and/or in documents
incorporated by reference herein.
The cautionary statements made pursuant to the Private
Litigation Securities Reform Act of 1995 above and elsewhere by
the Registrant should not be construed as exhaustive or as any
admission regarding the adequacy of disclosures made by the
Registrant prior to the effective date of such Act. Forward
looking statements are beyond the ability of the Registrant to
control and in many cases the Registrant cannot predict what
factors would cause actual results to differ materially from
those indicated by the forward looking statements.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
NORTH CAROLINA RAILROAD COMPANY
DATE: August 7, 1996 /s/ Lynn T. McConnell
Lynn T. McConnell, Treasurer and
Principal Financial Officer
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